Principles of Microeconomics

class: center, middle, inverse, title-slide

.title[
# Principles of Microeconomics
]
.author[
### ECO 2306
]
.date[
### <em>Fall 2022</em>
]

---

class: center, middle, inverse

# Chapter 10:
## Consumer Choice and Behavioral Economics

---

## Consumer Theory

.pull-left[
- We have looked at **what** people do, but not **why** they do what they do.

- Focus on demand side (consumers)

- Model decision making
  - Preferences
  - Constraints
  - Optimal choice
]
.pull-right[
<img src="data:image/png;base64,#images/why_would_you.gif" width="100%" style="display: block; margin: auto;" />
]

---

## Preferences and Happiness
.panelset[
.panel[.panel-name[Assumptions]

How do we model peoples' preferences?

.pull-left[

Need to make three assumptions:
1. Completeness
2. Transitivity
3. Non-satiation

These assumptions allow us to map preferences--a.k.a. **indifference curves**

- Suppose you are faced with three choices:
  - A: 2 pizza slices, 1 cookie
  - B: 1 pizza slice, 2 cookies
  - C: 2 pizza slices, 2 cookies
- Assume indifference between A and B
- Which do you prefer?
]
.pull-right[
<img src="data:image/png;base64,#images/more_cowbell.gif" width="90%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Indifference Curves]
.pull-left[
Assumptions
1. Completeness
2. Transitivity
3. Non-satiation

Properties
1. Prefer higher indifference curves
<font color = 'lightgrey'>
2. Indifference curves are downward sloping
3. Indifference curves *never* cross
4. Only one indifference curve through every bundle

</font>
]
.pull-right[
<img src="data:image/png;base64,#images/mit_2_1.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[IC 2]
.pull-left[
Assumptions
1. Completeness
2. Transitivity
3. Non-satiation

Properties

1. Prefer higher indifference curves
2. Indifference curves are downward sloping
<font color = 'lightgrey'>
3. Indifference curves *never* cross
4. Only one indifference curve through every bundle

</font>
]
.pull-right[
<img src="data:image/png;base64,#images/mit_2_2.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[IC 3-4]
.pull-left[
Assumptions
1. Completeness
2. Transitivity
3. Non-satiation

Properties
1. Prefer higher indifference curves
2. Indifference curves are downward sloping
3. Indifference curves *never* cross
4. Only one indifference curve through every bundle
]
.pull-right[
<img src="data:image/png;base64,#images/mit_2_3.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Utility]
Utility
- rank order bundles of goods/services on a scale (utility)
- **utility**: enjoyment or satisfaction people receive from consuming goods/services
- **Utils**
  - don't really exist
  - ordinal, NOT cardinal
  - e.g. football rankings vs. measurements/prices

What’s the purpose of utility?
- It allows you to rank choices
- It allows you to weight the different elements of your consumption bundle so you can rank them

**Utility function**: a stable, well-behaved mathematical representation of your preferences
- How do we represent your feelings about the tradeoff between pizza and cookes?
- `$U = \sqrt{P*C}$`

]

.panel[.panel-name[Marginal Utility]
**Marginal Utility**
- the change in total utility a person receives when consuming one additional unit of a good or service
- "marginal" means "additional"
- slope at a specific point on the utility function with respect to one of the choices

Key characteristics
- **Law of diminishing marginal utility**: consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period
- more of a good you have, the less happy you will be from the additional unit
- exceptions??
]

.panel[.panel-name[Utility Graphs]
.pull-left[
<img src="data:image/png;base64,#images/mit_2_4.png" width="100%" style="display: block; margin: auto;" />
]
.pull-right[
<img src="data:image/png;base64,#images/mit_2_5.png" width="100%" style="display: block; margin: auto;" />
]
]

]

---

## Deriving Indifference Curves

.panelset[
.panel[.panel-name[Marginal Rate of Substitution]
.pull-left[
**Marginal rate of substitution**
- The rate at which a consumer is willing to trade one good for another
- Internal terms of trade for a consumer so that he can trade two goods for one another and still maintain the same level of utility
- Given by the slope of the indifference curve
	
Mathematically, this is the ratio of marginal utility of good X to marginal utility of good Y
`$$MRS = -\frac{MU_X}{MU_Y} = -\frac{\Delta Pizza}{\Delta Cookie} = -\frac{MU_{cookie}}{MU_{pizza}}$$`

Intuitively, this is the rate at which you’re willing to substitute pizza for cookies
]
.pull-right[
<img src="data:image/png;base64,#images/mit_2_6.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Proof]
.pull-left[
We know:

$$
`\begin{aligned}
U &= f(X,Y)\\
\Delta U &= \frac{\delta f}{\delta X} \Delta X + \frac{\delta f}{\delta Y} \Delta Y
\end{aligned}`
$$
If two points are on the same indifference curve, then we know 
`$$\Delta U = 0$$`

So, 
`$$0 = \frac{\delta f}{\delta X} \Delta X + \frac{\delta f}{\delta Y} \Delta Y$$`
]

.pull-right[
Now, we solve for the slope, `$\frac{\Delta Y}{\Delta X}$`:

$$
`\begin{aligned}
-\frac{\delta f}{\delta X} \Delta X &= \frac{\delta f}{\delta Y} \Delta Y\\
-\frac{\delta f}{\delta X} &= \frac{\delta f}{\delta Y} \frac{\Delta Y}{\Delta X}\\
-\frac{\big(\frac{\delta f}{\delta X}\big)}{\big(\frac{\delta f}{\delta Y}\big)} &= \frac{\Delta Y}{\Delta X}\\
-\frac{MU_X}{MU_Y} &= \frac{\Delta Y}{\Delta X}
\end{aligned}`
$$
]
]

.panel[.panel-name[Application]

Starbucks drip coffee
- Tall (12oz): $1.85
- Grande (16oz): $2.10
- Tall costs $0.15 per oz
- Difference = $0.25 for 4 oz or $0.0625 per oz

Why is it priced like this?

]

---

## Budget Constraints
.panelset[
.panel[.panel-name[Overview]
.pull-left[
Given your income, how much of your income can you devote to various goods/services
- Assume your budget equals your income
- Devote all of your income to pizza and/or cookies

Graph
- x-intercept
  - income divided by price of cookies
  - given your income, how much of your income can you devote to cookies?
- y-intercept
  - income divided by price of pizza
  - given your income, how much of your income can you devote to pizza?
- slope = (negative) price ratio
]
.pull-right[
<img src="data:image/png;base64,#images/mit_3_1.png" width="100%" style="display: block; margin: auto;" />
]
]
.panel[.panel-name[Marginal Rate of Transformation]
.pull-left[
- **Example**
  - Income = $72
  - Pizza = $12
  - Cookies = $6
  - Just pizza => 6 pizzas
  - Just cookies => 12 cookies
  - Rate you trade cookies is `$-\frac{1}{2}$`
- **Marginal rate of transformation**
  - Slope
  - `$MRT = -\frac{P_C}{P_P}$`
  - Because of scarcity and tradeoffs, 
    - the more you spend on pizza, the less you spend on cookies (and vice versa)
    - so MRT gives us **opportunity cost**
    - opportunity cost of a slice of pizza is 2 cookies
]
.pull-right[
<img src="data:image/png;base64,#images/mit_3_1.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Price Change]
.pull-left[

- Income = $72
- Pizza = ~~$12~~ $18
- Cookies = $6

**Opportunity set** – the set of all choices available subject to your constraints
]
.pull-right[
<img src="data:image/png;base64,#images/mit_3_2.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Income Change]
.pull-left[

- Income = ~~$72~~ $60
- Pizza = $12
- Cookies = $6

Note: 
- You have less to spend, so the income to price ratios of the axes will be affected for both pizza and cookies
- The relative price of pizza and cookies hasn’t changed, so the slope doesn’t change
- The slope is controlled by market, but your income controls the level

]
.pull-right[
<img src="data:image/png;base64,#images/mit_3_3.png" width="100%" style="display: block; margin: auto;" />
]
]

]

---

## Utility Maximization

.panelset[
.panel[.panel-name[Intro]
How do consumers make choices?
- Indifference curves
- Budget constraint
- Maximize our utility subject to our constraints

With our utility function and budget constraint function, we can find our optimal bundle of pizza and cookies
]

.panel[.panel-name[Graph]
.pull-left[
Knowns
- utility function: 
`$$U=\sqrt{P*C}$$`
- budget constraint: 
$$\$72 = \$12Q_P+\$6Q_C$$

So what is the optimal bundle?

What is the utility at that bundle?

Why is that the best bundle?
]
.pull-right[
<img src="data:image/png;base64,#images/mit_3_4.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Tangency]
.pull-left[

The slope of the *budget line* is `$-\frac{P_C}{P_P}$` or `$-\frac{P_X}{P_Y}$`

The slope of the *indifference curve* is `$-\frac{MU_{Cookie}}{MU_{Pizza}} = -\frac{MU_X}{MU_Y}$`

So at the point of *tangency*, we have `$-\frac{MU_X}{MU_Y} = -\frac{P_X}{P_Y}$`

We have special names for these two ratios:
- `$MRS= -\frac{MU_X}{MU_Y}$`
- `$MRT=-\frac{P_X}{P_Y}$`

*Fundamental equation of consumer choice*: 
- `$MRS = -\frac{MU_X}{MU_Y} =-\frac{P_X}{P_Y} = MRT$`

]
.pull-right[
<img src="data:image/png;base64,#images/mit_3_4.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Non-tangency]
.pull-left[

So what if we are not at this point of tangency

- `$\frac{MU_X}{MU_Y} > \frac{P_X}{P_Y}$`
- `$\frac{MU_X}{MU_Y} < \frac{P_X}{P_Y}$`

The incentive is to trade until `$MRS = MRT$`
]
.pull-right[
<img src="data:image/png;base64,#images/mit_3_4.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Normal]
.pull-left[
**Substitution effect**: change in the quantity of a good when the price changes holding *utility* constant

**Income effect**: change in the quantity of a good as income changes holding *price* constant

**Normal good**: quantity demanded increases for the good as income rises

<font color = 'lightgrey'>
Inferior good: quantity demanded decreases as income rises
</font>
]
.pull-right[
<img src="data:image/png;base64,#images/mit_4_5.png" width="100%" style="display: block; margin: auto;" />
]
]

.panel[.panel-name[Inferior]

**Substitution effect**: change in the quantity of a good when the price changes holding *utility* constant

**Income effect**: change in the quantity of a good as income changes holding *price* constant

<font color = 'lightgrey'>
Normal good: quantity demanded increases for the good as income rises
</font>

**Inferior good**: quantity demanded decreases as income rises

Graph on board
]

.panel[.panel-name[Norm. vs. Inf.]
### Summary of Normal vs. Inferior Goods
<img src="data:image/png;base64,#images/tab_10_4.png" width="90%" style="display: block; margin: auto;" />

]

.panel[.panel-name[Demand]
.pull-left[
**Optimal Bundles**

- A: original optimal bundle

- B: price of cookies increases to $9

- C: price of cookies decreases to $4

What is a demand curve?

A feature of the utility function I chose is that it is only a function of income and that good’s price, not the price of the other good. Is this generally true?
]
.pull-right[
<img src="data:image/png;base64,#images/mit_4_1a.png" width="100%" style="display: block; margin: auto;" />
]
]

]

---

## Example: Optimal Bundles

.panelset[
.panel[.panel-name[Marginal Utility]

<table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Number of Slices of Pizza </th>
   <th style="text-align:center;"> Total Utility from Eating Pizza </th>
   <th style="text-align:center;"> Marginal Utility from the Last Slice </th>
   <th style="text-align:center;"> Number of Cups of Coke </th>
   <th style="text-align:center;"> Total Utility from Drinking Coke </th>
   <th style="text-align:center;"> Marginal Utility from the Last Cup </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> NA </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> NA </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> 20 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 36 </td>
   <td style="text-align:center;"> 16 </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 35 </td>
   <td style="text-align:center;"> 15 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 46 </td>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 45 </td>
   <td style="text-align:center;"> 10 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 52 </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 50 </td>
   <td style="text-align:center;"> 5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 54 </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 53 </td>
   <td style="text-align:center;"> 3 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 51 </td>
   <td style="text-align:center;"> -3 </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 52 </td>
   <td style="text-align:center;"> -1 </td>
  </tr>
</tbody>
</table>

]
.panel[.panel-name[Marginal Utility per Dollar]

Suppose that pizza costs $2 per slice and Coke $1 per cup.

<table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Number of Slices of Pizza </th>
   <th style="text-align:center;"> Marginal Utility from the Last Slice </th>
   <th style="text-align:center;"> Marginal Utility per Dollar </th>
   <th style="text-align:center;"> Number of Cups of Coke </th>
   <th style="text-align:center;"> Marginal Utility from the Last Cup </th>
   <th style="text-align:center;"> Marginal Utility per Dollar </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> 10.0 </td>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> 20 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 16 </td>
   <td style="text-align:center;"> 8.0 </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 15 </td>
   <td style="text-align:center;"> 15 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> 5.0 </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> 10 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 3.0 </td>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 1.0 </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 3 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> -3 </td>
   <td style="text-align:center;"> -1.5 </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> -1 </td>
   <td style="text-align:center;"> -1 </td>
  </tr>
</tbody>
</table>

]
.panel[.panel-name[Optimal Bundles]
.pull-left[
<table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Number of Slices of Pizza </th>
   <th style="text-align:center;"> Marginal Utility from the Last Slice </th>
   <th style="text-align:center;"> Marginal Utility per Dollar </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 10.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 16 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 8.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 5.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 3.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 1.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> -3 </td>
   <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> -1.5 </td>
  </tr>
</tbody>
</table>
]
.pull-right[

]

Recall: `$MB = MC$`

]
.panel[.panel-name[Optimal Bundles]
<table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Combinations of Pizza and Coke with Equal Marginal Utilities per Dollar </th>
   <th style="text-align:center;"> Marginal Utility per Dollar </th>
   <th style="text-align:center;"> Total Spending </th>
   <th style="text-align:center;"> Total Utility </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;width: 10cm; "> 1 slice of pizza and 3 cups of Coke </td>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> $2 + $3 = $5 </td>
   <td style="text-align:center;"> 20 + 45 = 65 </td>
  </tr>
  <tr>
   <td style="text-align:center;width: 10cm; "> 3 slices of pizza and 4 cups of Coke </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> $6 + $4 = $10 </td>
   <td style="text-align:center;"> 46 + 50 = 96 </td>
  </tr>
  <tr>
   <td style="text-align:center;width: 10cm; "> 4 slices of pizza and 5 cups of Coke </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> $8 + $5 = $13 </td>
   <td style="text-align:center;"> 52 + 53 = 105 </td>
  </tr>
</tbody>
</table>

Recall:
- Pizza costs $2 per slice 
- Coke costs $1 per cup

So you can calculate total spending and total utility

Your optimal bundle depends on your budget constraint.
- Which do you choose if your income is $5?
- Which do you choose if your income is $10?
]
.panel[.panel-name[Price Change]

Suppose the price of pizza falls to $1.50 per slice.

What is the optimal bundle?

<table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Number of Slices of Pizza </th>
   <th style="text-align:center;"> Marginal Utility from the Last Slice </th>
   <th style="text-align:center;"> Marginal Utility per Dollar </th>
   <th style="text-align:center;"> Number of Cups of Coke </th>
   <th style="text-align:center;"> Marginal Utility from the Last Cup </th>
   <th style="text-align:center;"> Marginal Utility per Dollar </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> 13.33 </td>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> 20 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 16 </td>
   <td style="text-align:center;"> 10.67 </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 15 </td>
   <td style="text-align:center;"> 15 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> 6.67 </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> 10 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 4.00 </td>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 5 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 1.33 </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 3 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> -3 </td>
   <td style="text-align:center;"> -2.00 </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> -1 </td>
   <td style="text-align:center;"> -1 </td>
  </tr>
</tbody>
</table>
]
]

---

## Example: Deriving Demand
.panelset[
.panel[.panel-name[Utility]

Suppose we face the marginal utility in the table from consuming pizza and cookies, your income is $3.00 and the price of cookies is $0.50.

Find the quantity demanded if pizza is priced at $0.50 per slice and then if it is priced at $1.00 per slice.

<table class="table table-striped table-hover table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Cookies </th>
   <th style="text-align:center;"> Marginal Utility (Cookie) </th>
   <th style="text-align:center;"> Marginal Utility per Dollar (Cookie) </th>
   <th style="text-align:center;"> Pizza Slices </th>
   <th style="text-align:center;"> Marginal Utility (Pizza) </th>
   <th style="text-align:center;"> Marginal Utility per Dollar (Pizza) </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;">  </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 120 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 120 </td>
   <td style="text-align:center;">  </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 100 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 60 </td>
   <td style="text-align:center;">  </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 80 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 45 </td>
   <td style="text-align:center;">  </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 60 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 30 </td>
   <td style="text-align:center;">  </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 40 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;">  </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 15 </td>
   <td style="text-align:center;">  </td>
  </tr>
</tbody>
</table>

]
.panel[.panel-name[MU/$]
.pull-left[
Pizza = $0.50
<table class="table table-striped table-hover table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Cookies </th>
   <th style="text-align:center;"> Marginal Utility (Cookie) </th>
   <th style="text-align:center;"> Marginal Utility per Dollar (Cookie) </th>
   <th style="text-align:center;"> Pizza Slices </th>
   <th style="text-align:center;"> Marginal Utility (Pizza) </th>
   <th style="text-align:center;"> Marginal Utility per Dollar (Pizza) </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">NA</span> </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">NA</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 120 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">240</span> </td>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 120 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">240</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 100 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">200</span> </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 60 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">120</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 80 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">160</span> </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 45 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">90</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 60 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">120</span> </td>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 30 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">60</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 40 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">80</span> </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">40</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">40</span> </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 15 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">30</span> </td>
  </tr>
</tbody>
</table>
]
.pull-right[
Pizza = $1.00
<table class="table table-striped table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Cookies </th>
   <th style="text-align:center;"> Marginal Utility (Cookie) </th>
   <th style="text-align:center;"> Marginal Utility per Dollar (Cookie) </th>
   <th style="text-align:center;"> Pizza Slices </th>
   <th style="text-align:center;"> Marginal Utility (Pizza) </th>
   <th style="text-align:center;"> Marginal Utility per Dollar (Pizza) </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">NA</span> </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;">  </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">NA</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 120 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">240</span> </td>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 120 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">120</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 100 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">200</span> </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 60 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">60</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 80 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">160</span> </td>
   <td style="text-align:center;"> 3 </td>
   <td style="text-align:center;"> 45 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">45</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 60 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">120</span> </td>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 30 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">30</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 40 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">80</span> </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">20</span> </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 20 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">40</span> </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 15 </td>
   <td style="text-align:center;"> <span style="     border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">15</span> </td>
  </tr>
</tbody>
</table>
]
]
.panel[.panel-name[Optimal Bundles]

Recall: Income = $3.00, want quantity demanded for pizza

**Bundles when Pizza Costs $0.50**

<table class="table table-striped table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:center;"> Bundles </th>
   <th style="text-align:center;"> Cookies </th>
   <th style="text-align:center;"> Price per Cookie </th>
   <th style="text-align:center;"> Pizza Slices </th>
   <th style="text-align:center;"> Price per Slice </th>
   <th style="text-align:center;"> Total Cost </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> A </td>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 0.5 </td>
   <td style="text-align:center;"> 1 </td>
   <td style="text-align:center;"> 0.5 </td>
   <td style="text-align:center;"> 1.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> B </td>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 0.5 </td>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 0.5 </td>
   <td style="text-align:center;"> 3.0 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> C </td>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 0.5 </td>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 0.5 </td>
   <td style="text-align:center;"> 5.5 </td>
  </tr>
</tbody>
</table>

<br>
**Bundles when Pizza Costs $1**

<br>
Note, we could use these quantities along with the associated prices to plot the demand curve.
]

]

---

## Experimental and Behavioral Economics

.panelset[
.panel[.panel-name[Intro]
> “The utility from drugs, crime, going bowling… 
> depends on whether friends and neighbors take drugs, commit crimes, go bowling…”
>
> <footer>---Gary Becker and Kevin Murphy</footer>

.pull-left[
Thus far, we assumed that people
- make choices independently of others
- are rational-make the optimal choice

This ignores 
- social aspects of decision making
- mistakes or limits of people (bounded rationality, self-interest, willpower)
]
.pull-right[
- Experimental Economics: 
  - people are recruited to participate in lab experiments 
  - rewarded with money to mimic real-world decision-making scenarios

- Behavioral Economics
  - studies of people making choices that do not appear to be economically rational
  - bounded rationality
]
]

.panel[.panel-name[Origins (Economics)]
Adam Smith (1700s)
- overconfidence
- loss aversion: more afraid of losing than they are eager to win
- self-control: more likely to pursue short-term than long-term benefits

Gary Becker (1970s)
- **network effects**: 
  - the demand of one consumer is increasing in the demand of others
  - popularity is self-reinforcing
- rational choice theory: stable preferences and engage in maximizing behavior
- crime and marriage models

]

.panel[.panel-name[Origins (Psychology)]
Kahneman and Tversky (1970s/80s)
- decisions are not always optimal--depends on framing, anchoring, etc.

- rules of thumb (availability heuristic): 
  - rely on easily recalled information, rather than actual data when evaluating the likelihood of a particular outcome
  - ex. bear or shark attacks

- prospect theory
  - loss aversion
  - $250 guaranteed vs. 25% chance of winning $1,000 and a 75% chance of winning nothing, most people will choose the sure win
  - Lose $750 guaranteed vs. 75% chance to lose $1,000 and a 25% chance to lose nothing, most people will risk losing $1,000
  - most people willing to take a greater risk if it means avoiding a $1,000 loss versus obtaining a $1,000 win
]

.panel[.panel-name[Richard Thaler]
- **endowment effect**: an emotional bias that causes individuals to value an owned object higher, often irrationally, than its market value
- **sunk cost fallacy**: the idea that people will continue to invest in a losing project simply because they are already heavily invested, even if it means risking more losses
- mental accounting: 
  - the idea that people treat money differently based on context
  - ex.: drive across town to save $10 on a $20 football but won't to save $10 on a $1,000 TV
- libertarian paternalism
  - libertarian because it preserves choice
  - paternalistic because it encourages certain behavior
- **nudge**: 
  - a conceptual device for leading people to make better decisions
- Nudging examples
  - retirement: default into 401k
  - healthcare: 
    - putting fruit at eye level or near the cash register at a high school cafeteria
    - default to organ donor status
  - *Not*: banning junk food, or punishing people for choosing unhealthy options
       
]
.panel[.panel-name[Other concepts]
.pull-left[

Altruism
- motivated solely by the desire to provide for a recipient

Warm glow
- people experience a sense of joy and satisfaction for "doing their part" to help others
- this satisfaction - or "warm glow" - represents the selfish pleasure derived from "doing good", regardless of the actual impact of one's generosity
- "...a millionaire does not really care whether his money does good or not, provided he finds his conscience eased and his social status improved by giving it away..." -George Bernard Shaw
]

.pull-right[
Fairness
- social preference for equitable outcomes
- inequity aversion: people’s tendency to dislike unequal payoffs in their own or someone else’s favor
- ex: employers often agree to pay more than the minimum the employees would accept in the hope that this fairness will be reciprocated

Trust
- increases when people are closer socially or have high status
- but less trust when people come from different social groups (e.g. nationality)
]
]
]

---